Asian private enterprise: on life support

April 2nd 2020 | Multiple countries | Consumer goods

A lasting slump in both domestic and external demand during the coronavirus pandemic will require unprecedented policy efforts to avoid the wide-scale collapse of private sectors in Asia and Australasia.

Countries throughout the region are already refining their monetary and fiscal policy efforts towards supporting small and medium-sized enterprises.

The large sizes of informal sectors in many Asian economies puts the onus on fiscal policy, owing to the risk of slow or partial monetary policy transmission.

Private-sector debt crises and the mass collapse of firms is a possibility in some countries if governments do not move fast enough or tailor responses to the particulars of their economies.

Governments across Asia and Australasia are deliberately shutting down much of their economies to slow the spread of coronavirus. However, pressure is mounting to ensure that those same measures do not bankrupt the firms that generate the majority of economic output and employ billions of workers. The mass collapse of firms, both large and small, would deepen the economic downturn and slow the recovery that will eventually take place. Widespread bankruptcy of companies would also imperil banks and other lenders, leading to greater strain on national governments.

The immediate focus is on ensuring financial systems have the liquidity that companies need to continue to borrow and avoid defaults on their debts. A second aim will be to bolster demand once lockdowns ease and supply conditions normalise. However, the timing for kick-starting demand remains uncertain, given how little is known about the nature of the virus. Governments and central banks are, therefore, faced with an open-ended timeline, during which they will need to extend and broaden policy efforts. Even under our forecast that the pandemic will begin to be brought under control globally by mid-2020, the policymaking required to avert even partial private-sector collapse will be unprecedented in scope.

A monetary response to start

For most countries in the region, the possibility of a banking-sector crisis that might prevent access to credit or liquidity is slim. Although credit provision has risen at a faster pace than economic growth in many Asian economies over the last decade, most banks have kept this potential risk at bay. National banking sectors have, on the whole, remained well capitalised and have met prudential requirements that far exceed mandatory provisions in place prior to the 2008-09 financial crisis. By 2019 the majority of countries in Asia had ensured their traditional lending sectors had met at least Basel-III risk-based capital and liquidity requirements (international prudential banking standards developed by the Bank for International Settlements), although, notably, Bangladesh has struggled to meet these thresholds.

As such, the immediate priority in the context of non-financial firm financing is ensuring that the cost of borrowing does not become prohibitive. Accordingly, monetary authorities are undertaking a drastic loosening of policy. Since February, almost all central banks in the region have cut their policy interest rates. They have also taken drastic measures to increase liquidity among lenders. In many cases, this has included ramping up short-term government securities repurchase (repo) operations—a temporary injection of money via central bank lending. Some monetary authorities, including those of Japan, South Korea, the Philippines and Australia, have also introduced or expanded quantitative easing (QE) programmes—a permanent injection of money via secondary-market asset purchases.

Discernible among this wide array of monetary policy actions is an emerging trend of highly directed initiatives. These aim to ensure that increased liquidity among lenders is better channelled into specific areas of the economy, including towards smaller firms. So-called "funding for lending" programmes require that commercial banks use tranches of discount-window borrowing to lend to small or medium-sized enterprises (SMEs). Taiwan and Australia announced such schemes in mid-March, both lasting for a year. The Reserve Bank of Australia (RBA, the central bank) has provided further incentives within its scheme by offering a second tranche of the facility on condition of loaning out the first to the target segment. It is likely that other monetary authorities will roll out similar programmes in the coming months.

An increasing number of countries are also likely to mandate debt moratoria for struggling borrowers. Banks in Thailand, Sri Lanka and Singapore have already agreed to defer repayments on loans for varying periods of up to a year. These initiatives will mainly be directed at SMEs.

The advantages of fiscal policy in emerging markets

Even under the conditions of cheaper loans and postponed repayments, however, the private sector is still hemmed in by a narrower range of funding types. In the immediate term, the cost of issuing corporate bonds will be prohibitively high for many emerging-market firms, even if they meet investment-grade rating standards, while public offerings on stock markets will be all but ruled out. Moreover, large informal sectors in many countries in the region consist of firms that already face restricted access to finance, owing to their sub-legal status or a lack of suitable collateral. These companies are hugely important for employment and, by extension, the livelihoods of the local population, so the wide-scale collapse of this segment (represented by a sell-off or abandonment of productive capital) would have an outsized negative impact on economies and political stability.

Given these considerations, the role of fiscal policy in directly supporting private businesses will be far larger than in previous crises. Many governments, including those of Japan, South Korea, Vietnam, Sri Lanka and Mongolia, have already allowed the deferral of payment of various commercial taxes, while others, such as Cambodia, Thailand and China have announced substantial tax concessions or tax holiday periods. More are likely to do so in the coming months. The governments of New Zealand, South Korea and Singapore have also stepped in to subsidise companies' wage bills. However, these policies will still do relatively little for informal-sector firms, which exist largely outside of the tax base and often have no formal accounting.

There will, therefore, be an impetus for the governments of low- and middle-income economies to extend direct transfers to households, which will, by extension, provide support to small, informal enterprises. The importance of the fiscal channel will be enhanced by the difficulties monetary authorities face in transmitting monetary policy loosening to the shadow finance sector. This includes not only large financial intermediaries but also micro-lenders, which are key financing channels for the informal economy.

Just the beginning

Despite the best efforts of states, as the pandemic goes on, it will present growing problems for the private sector, owing to the nature of the public health response. Amid social distancing and quarantine measures that have wiped out final demand, the large-scale fiscal and monetary stimulus measures detailed here will serve only to roll over existing debts for many firms. In many cases, private debt will rise even further.

Rising debt ratios—the share of liabilities to assets (effectively firms' revenue streams)—will lead to upward pressure on borrowing costs as risk premiums rise, undoing the benefits of monetary easing. Consequently, The Economist Intelligence Unit expects governments in the region to provide more funding directly to businesses and to offer state guarantees on new credit and debt rollovers, to offset rising premiums. As with other policy efforts, these will be tailored primarily towards SMEs. Indeed, Hong Kong, Malaysia and Japan have already introduced automatic state guarantees for loans to SMEs where lenders have accessed certain central bank funding facilities (or across the board in the case of Hong Kong).

Grim possibilities

There nevertheless remains a significant risk of partial private-sector collapse (mass bankruptcy among formal-sector enterprises and mass liquidation or abandonment of productive capital among informal-sector businesses) in some countries). This could be the result of, for instance, policymaking moving too slowly or governments deciding against comprehensive fiscal support in view of perceived fiscal constraints.

The table below assesses factors that could contribute to private-sector debt crises and mass firm collapse. It focuses on three areas: initial private-sector conditions, the domestic impact of the pandemic and potential constraints on public and private access to financing. This includes upward pressure on lending costs, debt-exchange rate risks, government capacity to respond, and informal-sector size, among other considerations. Green indicates more favourable conditions, while yellow and red point to less favourable and unfavourable conditions, respectively.

Although, for most countries, the thresholds indicate a level beyond which concern is warranted, there are exceptions. Notably, Hong Kong records a high share of private external debt and domestic credit to the private sector as equivalent shares of GDP, but this is owing to the exceptionally large size of its financial services sector. Japan's public debt is largely domestically held and exceeds its stock of M2 money, but its extensive use of unconventional monetary policy, including negative rates, quantitative easing and yield curve control, keep commercial interest rates low. Australia and New Zealand exhibit several less favourable factors, but this is, to a large extent, offset by advanced bureaucracies, including well-developed welfare systems, and both sovereigns' relative ease of access to international capital markets.

In contrast, Thailand's overall vulnerability is more than the indicators in isolation suggest. The economy is heavily dependent on tourism, which has been reduced to marginal activity levels and is likely to lag containment of the outbreak by several months. In addition, it has a large export-oriented manufacturing sector, which has been battered by disruption to supply chains and a drop in external demand. Underlying these issues are high levels of household debt, which will slow a recovery in domestic demand and could contribute to the collapse of small businesses, many of which are in the tourism sector. The dominance of the informal sector may also make it more difficult for the government to intervene in a targeted way to assist businesses. More positively, the banking sector has the capacity to absorb a strong rise in bad debts and the government has significant space to raise spending before debt-servicing costs become unmanageable.

India is also vulnerable. In particular, its banking sector faces a high share of non-performing loans (NPLs), which have already contributed to the failure of several large lenders prior to the pandemic. With the onset of a nationwide lockdown in late March, the risk of commercial bank liquidity crunches or even insolvency will rise. We are confident that the state will be able to recapitalise major banks but the risk of disruption to private-sector funding during these difficult processes is high. If fiscal stimulus efforts are not sufficiently timely or well administered, a collapse in informal-sector enterprise could follow, with severe consequences for the wider economy. Pakistan and Bangladesh will be in similar situations if the pandemic forces strict lockdowns in those countries as well. Their external accounts are in a precarious position and Pakistan, in particular, will face harsher fiscal constraints than most, given its already large public debt burden and a recent balance-of-payments crisis that has left it with few borrowing options.

Who will pick up the bill?

Even if wide-scale defaults on private debt and partial collapse of the private sector are avoided, the cost of fending off the worst economic effects of the pandemic will be huge. Sustaining households and firms through the outbreak will entail a substantial enlargement of public debt and, in some cases, expansions of central banks' balance sheets that may restrict their future policy options. However, the economic costs will be lower than under a scenario of mass private enterprise failure. Asia's governments are sure to do all they can, but this is uncharted territory and success cannot be guaranteed.